Zone Pricing: How Retailers Can Capture Value and Increase Competitiveness

Like the ancient merchant who haggles with different customers, today's brick-and-mortar retailers can de-average their prices as they invariably have stores located in very different environments.

Every store is different—down to the customers it serves and the other stores it competes against. Fortunately, retailers generate a huge reservoir of rich transactional data from loyalty programs and credit cards. Together with geospatial analytics and competitor price shops, this provides a well of information that can help retailers understand local customer preferences; price sensitivities; and product affinities across stores, categories, and products. Ultimately, this enables the retailer to segment the store footprint into "pricing zones," with different willingness-to-pay levels based on observed shopping behavior rather than artificially set geographical boundaries.

A Four-Step Approach to Zone Pricing

To take advantage of this complex web of information, BCG has developed a four-step approach for retailers to design a sound zone-pricing strategy.

What a customer is willing to pay for a product at a given store depends on a long array of factors, including disposable income, living costs, and the ease with which you can purchase the product elsewhere. The relevant customer characteristics and demographics to study stretch well beyond the usual suspects. For instance, household income is often a poor stand-alone predictor of willingness to pay, while certain products, such as on-demand subscriptions, have no straightforward relationship to income levels. Tapping into deep transaction-level data can add flavor to consumers’ purchasing patterns; for example, tendencies to buy more premium products on the good-better-best ladder.

The challenge when developing a zone pricing strategy is making full use of the data while getting to insights that can easily be understood, communicated, and incorporated into a strategy. Through statistical methods made to handle large amounts of data, our methodology uncovers a handful of drivers that together explain the majority of the variance in willingness to pay across the store landscape. When taken together, this strategy can predict the level of willingness to pay for each store by considering the most relevant local characteristics.

Once the drivers of willingness to pay are understood, the next dimension to consider is the competitor alternatives in the store’s trade area. Retailers need to understand which competitors (across all relevant retail sectors and channels) matter for which categories, as well as the relative importance of each competitor to the business.

Local price levels will vary depending on the composition of retailers, their price levels (and potentially zone pricing strategies), and logistics costs. Local prices, including promotional pricing, will influence consumer price expectations and are critical to analyze.

Not all categories or items are created equal. Some react similarly to the same drivers such as customer characteristics and competitive alternatives in the trade area; others do not. Accounting for different category dynamics applies not only to mass retailers with multiple departments, but also to restaurants or specialty retailers. For example, in sporting goods, the shoes and apparel sections will be much more heavily influenced by the nearby shoe stores or department stores than the tennis racquets and golf clubs sections.

In addition, customers may also have especially high price awareness on certain key value items (KVIs) where price levels will heavily influence total store value perception and customer traffic. Items with less price awareness and sensitivity (such as balsamic vinegar) can float up a little to capture value and support the investment into KVIs, without affecting overall store price or value perception. Historically, grocery retailers have aggressively pursued such strategies with "everyday low prices" on reference products such as milk, household paper products, and detergent.

Sophisticated zone pricing strategies will incorporate these category and item nuances to allow certain sections of the business or categories to follow a different set of zone rules than others.

Once the new strategy has been designed, specific attention must be dedicated to its operations. Technology solutions—either third-party tools or BCG’s proprietary technology—allow for simple and efficient front-ends for pricing teams to manage the complexities. With the help of deep analytical tools, this complicated process can become a simple and scalable exercise that allows for the agility and nimbleness needed by retailers today.

Because a well-designed zone strategy invests smartly, transforming a retailer's pricing strategy can expand total business margins by 50 to 150 basis points, while investing to increase price competiveness where it matters the most.

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